Fuels rush in

Why the U.S. market is tough for Manitoba power sales

Natural gas is burned off at well sites east of Williston, N.D., in the heart of the Bakken oil region. (TRIBUNE MEDIA MCT)

Hydroelectric generation is no longer a preferred cheap source of electricity.

Recent massive structural shifts in the North America electrical energy industry shine a new light on old assumptions that have persisted for several decades. The entrance of new energy sources and cost efficiencies have set the stage for a rethink. To complicate the matter, new environmental concerns require assessments of options in the context of regional and local situations. There is no one best generation option that stands out. Local realities and choices differ by region.

Manitoba Hydro (or the Manitoba government -- hard to tell them apart these days) is betting ratepayers' (taxpayers') money on new dam construction on the Nelson as a business investment. The intent is to produce a significant amount of additional electrical energy to serve U.S. demand, thus paying off the new investments and keeping Manitoba electrical rates low.

The Manitoba government wins in this gamble, because it reaps revenues both from Hydro's borrowing and from water-rental rates, allowing it to reduce the substantial deficits it is now running.

The numbers are so large they boggle the mind of citizens whose greatest worry is to get by to the next payday. A successful business owner must wonder how due diligence could lead anyone to the conclusion that this would actually work.

Technically, there is no doubt Hydro could build the dams and increase Manitoba's electrical output.

The big question is who would buy it? If it can't be sold, or only sold at discount prices below the cost of production, who pays the difference?

Where's the demand for hydro power in the U.S. that Manitoba says it could access?

In 1950, the U.S. generated about 334 million kilowatt hours: 46 per cent from coal, 30 per cent from hydro, 13 per cent from natural gas and 10 per cent from petroleum. Renewables didn't exist except for a few farm windmills pumping water for livestock.

In 2012, the U.S. generated slightly over four billion kilowatt hours of electricity. Coal had dropped to 37 per cent of all production, natural gas up to 30 per cent, nuclear at 19 per cent, hydro at seven per cent and renewables about five per cent. Petroleum has virtually disappeared.

U.S. coal-fired generation peaked in 2007, while natural gas generation has grown steadily since its inception prior to 1950.

Within the U.S., there are physical limitations to hydro opportunities within the "lower 48," so there is little room for growth. That leaves nuclear and natural gas, although the former is not a public favourite.

Renewables are expensive. Even though costs are dropping, they are still significantly higher than other options. Over the long run, however, solar will become competitive, wind will be a useful component of a mix in certain locations.

Other fuels (e.g. biomass) will play useful roles in particular cases. Additional technologies are on the horizon, and designing generation units to fit local needs will become a growing trend that saves transmission losses.

Markets for Manitoba hydro power conceivably might be found in North Dakota, Minnesota and Wisconsin, which will experience about the same rate of demand growth as Manitoba. Together, they have 131 coal-fired electrical generating stations at 57 locations that are heavy polluters. These will gradually have to be phased out or redesigned for cleaner operation, so what and who will pick up the load?

Don't bet on Manitoba Hydro to be the saviour.

The cost per kilowatt hour of power from the Nelson delivered to these markets will most certainly be in excess of 10.5 cents for generation, plus another 3.5 cents to get it as far as Winnipeg. These figures are for Wuskwatim, but are a reasonable proxy for Conawapa 12 years down the road. Gas-fired turbines are far more competitive than that. Gas-fired turbines combined with steam are even more efficient, and there are proven domestic natural gas reserves within or nearby adjacent states to supply fuel for many decades into the future.

Natural gas from the Bakken formation in Montana, North Dakota, Manitoba and Saskatchewan will be available for decades into the future. Unfortunately, about one-third of current production is flared off, due to scattered drill sites and lack of gas-transportation capacity. Firm demand for it will assure availability for electrical-generation use.

Natural gas generates less than half the CO2 emissions per megawatt hour (MWh) compared to coal: less than one per cent sulfur oxides at the plant; and less than a third as much nitrogen oxides. Hence, replacing coal with natural gas would cut U.S. emissions considerably. Moreover, CO2 can be captured and stored, adding to the benefits of natural gas.

The basic question is why would neighbouring states buy Manitoba's electricity when they can produce their own cheaper?

The question for Manitoba, however, is quite different. Why would Manitoba invest billions when the market is clearly stacked against them?

It takes time to build a major dam such as Conawapa. This means from Day 1, when the first design work began, Hydro began to incur costs. These costs are paid with borrowed money, either from outright loans or from transfers from revenue. Interest begins to accrue at this point, and there is no revenue to pay it back until a sale is made. Interest rates have been low for some time, but this will change, so carrying charges are predictably significant. Sales won't happen until the dam is operational and revenue begins to flow from firm contracts. Apparently, Hydro thinks this will happen about 2025 or so, assuming there are no delays and there is in fact a market. Clearly, over a period of 12 years, a considerable debt, including compound interest charges, will have accumulated.

This predictable debt needs to be offset with a high degree of assurance the power the new dam produces will actually be sold at prices sufficient to at least cover operational costs and carrying charges.

More importantly, it must be sold at a price that is sufficient to begin to pay down the debt. The spot market will not meet this need, and solid contracts need to be in place to give confidence to Manitoba ratepayers and taxpayers, together, that they will not be directly liable.

The PUB is now reviewing this whole matter. Hopefully, clear and substantial answers to these questions are forthcoming from Hydro, including actual contract-negotiation data. A recent agreement that Hydro will provide this information to the PUB also stipulates it will be treated as "secret." Manitoba Hydro has no credibility to simply say: "trust us." It remains to be seen whether the PUB is able to apply objectivity in its review under these circumstances.

A natural gas plant at Brandon would serve domestic demand while a careful assessment is completed, using natural gas from the same Bakken formation that makes Nelson River hydro power non-competitive.

Jim Collinson is a management consultant specializing in the complexities surrounding energy, economic and environmental issues.

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